A limited constitutional government calls for a rules-based, freemarket monetary system, not the topsy-turvy fiat dollar that now exists under central banking. This issue of the Cato Journal examines the case for alternatives to central banking and the reforms needed to move toward free-market money.

The more widespread use of body cameras will make it easier for the American public to better understand how police officers do their jobs and under what circumstances they feel that it is necessary to resort to deadly force.

Americans are finally enjoying an improving economy after years of recession and slow growth. The unemployment rate is dropping, the economy is expanding, and public confidence is rising. Surely our economic crisis is behind us. Or is it? In Going for Broke: Deficits, Debt, and the Entitlement Crisis, Cato scholar Michael D. Tanner examines the growing national debt and its dire implications for our future and explains why a looming financial meltdown may be far worse than anyone expects.

The Cato Institute has released its 2014 Annual Report, which documents a dynamic year of growth and productivity. “Libertarianism is not just a framework for utopia,” Cato’s David Boaz writes in his book, The Libertarian Mind. “It is the indispensable framework for the future.” And as the new report demonstrates, the Cato Institute, thanks largely to the generosity of our Sponsors, is leading the charge to apply this framework across the policy spectrum.

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Archives: 03/2008

Another (fictitious) dispatch from my anonymous correspondent on the campaign trail:

LANCASTER, Pa. — Sen. Barack Obama told a crowd of enthusiastic supporters here that the North Korean concept of “Juche,” its stated policy of complete economic and social independence and isolation, is “intriguing” and worthy of further study as a possible antidote to the economic malaise of the state in recent years.

The comment on Juche (pronounced “joo-CHEH”) came as a response to a question from a voter who expressed doubt that a repeal of NAFTA would help the region’s economy. Obama’s remark took the campaign’s message of economic nationalism and support for the weakened manufacturing sectors of the upper Midwest well beyond the rhetoric espoused by his Democratic primary opponent, Sen. Hillary Clinton.

“Trade is not helping the Pennsylvania economy get back its jobs,” Obama told the questioner. “And it may be time to quit tinkering with a system that stopped working a long time ago and get back to the basics.”

“Now we’re talking!” enthused Dean Baker, co-director of the Center for Economic and Policy Research, a D.C. think tank. “Someone finally had the guts to go all the way. Hallelujah!”

A spokesperson for the Obama campaign stressed that the senator was not articulating an official policy position but merely discussing aloud an idea that the campaign’s economic advisers have been contemplating for some time.

Obama said that his one reservation with such an economic system is that North Korea’s economy has struggled a bit in recent years. He attributed those struggles more to execution than policy, along with a rash of bad weather. Autarkic economic self-reliance, he averred, would provide a needed tonic to the U.S. economy and work especially well in the recession-plagued Midwest.

CNN broadcaster Lou Dobbs, a noted critic of U.S. trade policy in recent years, extended cautious praise for Obama’s words. “American economic woes are far more severe than North Korea’s, and we need a stronger dose of Juche than what Pyongyang employs. Pennsylvania would benefit little from a system that merely closes off imports from other countries. To truly help, we need to allow the state to ban imports from other states as well. Obama’s comments were a little timorous for me and revealed how out of touch he and the rest of the D.C. elites really are.”

Obama’s audience seemed quite receptive to the idea. “I’ve never heard of Juche before, but when he explained it a bit I thought it made perfect sense,” said Thaddeus Verhoff, an unemployed sheet welder from nearby Mt. Joy.

Other analysts hailed the proposal as a deft political move. “Rather than continuing to take baby steps around each other, Obama has jumped ahead to the inevitable end point of the debate without giving Senator Clinton any room to get to his left,” said John Cavanaugh, a columnist at Roll Call. “All she can do now is criticize him for being too protectionist, which doesn’t fly in Democratic circles.”

The Clinton team has yet to formally respond to Obama’s comments. A campaign spokesperson did indicate to reporters that Clinton would “stoop to no one” in her defense of state economic sovereignty.

A column in the Wall Street Journal discusses Senator Obama’s plan to boost the top tax rate on entrepreneurs and investors from less than 38 percent to more than 50 percent. This huge tax increase will significantly undermine incentives to both earn and report income. As a result, the author, formerly with the Social Security Administration, explains that behavioral responses will result in far less money than projected by “static” revenue estimates:

Mr. Obama has recently veered sharply left. He now proposes to solve the looming Social Security shortfall exclusively with higher taxes. …Currently, all wages below about $100,000 are subject to a 12.4% Social Security payroll tax. But all wages above that amount are not subject to the tax. Mr. Obama wants to eliminate the cap, but, in a concession to taxpayers, exempt wages between $100,000 and $200,000. …Mr. Obama’s plan would keep Social Security in the black for only three additional years. Under his proposal, annual deficits would hit in 2020, instead of 2017. By the 2030s the system would still run an annual deficit exceeding $150 billion. Mr. Obama’s modest improvements to Social Security’s financing come at a steep cost. …The top marginal federal tax rates would effectively increase to 50.3% from 37.9%, equivalent to repealing the Bush income tax cuts almost three times over. If one accounts for behavioral responses, even the modest budgetary improvements from Mr. Obama’s plan are likely to be overstated. If employers reduce wages to cover their increased payroll-tax liabilities, these wages would no longer be subject to state or federal income taxes, or Medicare taxes. A 2006 study by Harvard economist and Obama adviser Jeffrey Liebman concluded that roughly 20% of revenue increases from raising the tax cap would be offset by declining non-Social Security taxes. Assuming modest negative behavioral responses, Mr. Liebman projected an additional 30% reduction in net revenues, leaving barely half the intended revenue intact. Mr. Obama’s plan would also dramatically raise incentives for tax evasion, further degrading revenue gains. Many high-earning individuals evade the Medicare payroll tax by setting up “S Corporations,” paying themselves in untaxed dividends rather than taxable wages. John Edwards avoided $590,000 in Medicare taxes this way in the 1990s. …The U.S. already collects far more Social Security taxes from high earners than other countries do. Social Security taxes here are currently capped at about three times the national average wage – far above other developed countries. In Canada and France payroll taxes are levied only up to the average wage. In the United Kingdom, taxes stop at 1.15 times the average wage; in Germany and Japan at 1.5 times.

Obama also wants to let the Bush tax cuts expire, which means the top tax rate would rise even farther - to more than 55 percent. But the bad news may get even worse. It is unclear how Obama will “fix” the alternative minimum tax. If his Social Security plan is any indication, he may propose to raise the top rate even further. What would all this mean? Simply stated, European-style tax rates will mean European-style stagnation.

The news that the commander of U.S. Central Command, William “Fox” Fallon, is retiring early is going to cause some panic among people concerned about war with Iran. There’s some reason to worry, but not much more than yesterday. Time will tell, but I don’t think this is about bombing Iran.

Whether Fallon got fired or resigned, it happened because he screwed up — he got caught disagreeing with administration policy in an overwrought article by Thomas Barnett in Esquire. Even before that, it was a terribly kept secret that he was out of sync with the White House on Iran, Iraq, and probably China.

I agree with Fallon on all those fronts, but he works for the president. Civilian control of the military means you can’t just go around telling everyone, off the record or no, that you dissent from the administration’s policies, and still work for them, even if those policies are dumb. It’s probably Fallon’s good sense that made it impossible for him to work for this administration.

Democrats who take his side because they dislike Bush administration policy ought to keep in mind that a president they support may be in power soon, and they’re going to have to run the military too.

Andrew and Adam have been fileting the Weekly Standard already today, but while I’ll happily defer to them on education policy, the Standard’s blog is advancing some honest-to-goodness foreign policy nonsense that shouldn’t go unremarked.

Here they are grousing about Obama’s claim that “the continuation of a presence in Iraq as Sen. McCain has suggested is exactly what, I think, will fan the flames of anti-American sentiment and make it more difficult for us to create a long-term and sustainable peace in the world.” Now, this is so painfully obvious as to be banal, but here’s the Standard’s response:

Never mind that farm subsidies–as in the policy Obama defended vociferously while pandering to Iowans a few months back–leave the poorest people in the world starving and without jobs.

Now, farm subsidies are truly a terrible idea. But if the Standard somehow believes that we’re hated in the Islamic world because of sugar subsidies, I’ve got a bridge I’d like to sell them. The list of evidence to the contrary is too long for this forum, but here’s just a start:

“American direct intervention in the Muslim World has paradoxically elevated the stature of and support for radical Islamists, while diminishing support for the United States to single-digits in some Arab societies…Muslims do not ‘hate our freedom,’ but rather, they hate our policies.”

“All of our panelists agreed that U.S. foreign policy is the major root cause behind anti-American sentiments among Muslim populations and that this point needs to be better researched, absorbed, and acted upon by government officials.”

“[Deputy Defense Secretary Paul] Wolfowitz also estimated the U.S. cost of Iraqi ‘containment’ during 12 years of U.N. sanctions, weapons inspections and continued U.S. air patrols over the country at ‘slightly over $ 30 billion,’ but he said the price had been ‘far more than money.’ Sustained U.S. bombing of Iraq over those years, and the stationing of U.S. forces ‘in the holy land of Saudi Arabia,’ were ‘part of the containment policy that has been Osama bin Laden’s principal recruiting device, even more than the other grievances he cites,’ Wolfowitz said.

Implying that a takeover in Iraq would eliminate the need for U.S. forces in Saudi Arabia, and thus reduce the appeal of terrorist groups for new members, Wolfowitz said: ‘I can’t imagine anyone here wanting to spend another $ 30 billion to be there for another 12 years to continue helping recruit terrorists.’

-Washington Post, March 2, 2003

We could go on like this for days. Farm subsidies are dumb enough on their own, we don’t need to delude ourselves into thinking they’re what’s to blame for 9/11. In fact, if the Standard and its adherents continue with this sort of fantacism, we’re going to continue avoiding the real root of our terrorism problem, which is evident enough that the above sources and anyone else paying attention can see it all too plainly.

Shortly after one of these articles appeared I received a phone call at home from an investigative reporter with one of the largest New York newspapers. He prodded me for quite a while to find out if I had been influenced or bribed by one of the companies Spitzer had attacked. Did I know anyone at, say, Merrill Lynch? (Nope). Do I own stock in the company? (Not then, and I’m currently shorting financials.)

I explained that nobody has accused me of any breach of integrity since I began writing in 1971. Besides, it would be very expensive to bribe me, I joked, because I had accumulated more money through investing than I know how to spend. I asked the reporter where he had gotten this very bad tip. He told me he had been contacted by Mr. Spitzer’s office. Hardball was their favorite game.

What follows is an unpublished February 2005 speech I gave to some small group in D.C. (which paid me less than half what Gov. Spitzer apparently spent for far less entertainment). Excerpts later appeared in my “Trial by Press Release.”

——

Regulation by Litigation
By Alan Reynolds

“I was asked to say a few kind words about Eliot Spitzer. But that would be such a difficult chore I would be compelled to charge an exorbitant fee for an extremely short talk. In the interest of frugality, I’ve decided to tell you what I really think.

Conflict of interest might be a good place to start.

When travelers use a travel agent, the agent is apt to be paid a commission only by certain hotels, tours and cruises. If customers view that as “a conflict of interest,” they might worry about being steered to an overpriced vacation at some place they don’t really want to visit.

When jobseekers use an employment agency to find a job, the commission is likely to be paid by the employer. If customers view that as a “conflict of interest,” they might worry about being steered to the wrong job at the wrong salary.

When consumers go to a State Farm office to inquire about home or car insurance, the agent they talk to is paid by State Farm. If customers view that as a “conflict of interest,” they may worry about being steered to the wrong policy at an inflated price.

When homebuyers buy a house, the realtor is usually paid a commission by the seller. If customers view that as a “conflict of interest,” they might worry about being steered to the wrong house and paying an inflated price.

In fact, consumers are neither naïve or gullible, so they don’t share Mr. Spitzer’s paranoia about conflicts of interest. On the contrary, the fact that many sorts of brokers and agents are often paid by sellers rather than buyers suggests this is a method of compensation all parties must find mutually satisfactory, otherwise it would not have survived in the competitive marketplace.

“Conflict of interest” does not depend on whether brokers are paid by sellers or buyers, because any broker who did not continually earn a good reputation by taking care of customers would soon lose clients to those who do. Insurance companies have no incentive to pay contingent fees to brokers who cannot attract and retain moderate-risk corporate customers for their policies, for example.

PRESUMPTION OF GUILT

Moving on to Eliot Spitzer’s lucrative backroom deals with financial firms, mutual funds and insurance brokers, we have to start with a big question: Why do companies like Merrill Lynch or Marsh & McLellan rush to settle if they’re not guilty?

Answer: The Martin Act. The 1921 Martin Act gives New York’s AG unique power to smear a company, industry or profession in the press, and to threaten to unleash interminable class action suits unless the target companies write a big check to Albany. Power corrupts and Mr. Spitzer has too much of it. From his point of view, power is delightful and absolute power is absolutely delightful.

The Martin Act has been called “the legal equivalent of a weapon of mass destruction.” Writing in Legal Affairs last June, Nicholas Thompson explained that the Martin Act empowers the New York attorney general “to subpoena any document he wants from anyone doing business in the state… People called in for questioning during Martin Act investigations do not have a right to counsel or a right against self-incrimination… . To win a case, the AG doesn’t have to prove that the defendant intended to defraud anyone, that a transaction took place, or that anyone actually was defrauded. Plus, when the prosecution is over, trial lawyers can gain access to the hordes of documents that the act has churned up and use them as the basis for civil suits.”

That last feature – the fact that Spitzer’s e-mail collections are irresistible bait for class action lawyers– makes it suicidal for any company to challenge a Martin Act accusation. The vagaries of the law make it too easy to be found guilty of fraud for simply being careless or unclear. And any admission or finding of guilt would soon bring an unbearable flood of class actions suits.

In the ULR complaint, for example, the company stands accused of not making “appropriate” disclosure, and of misrepresenting “the reasonableness of their compensation.” Since “appropriate” and “reasonableness” are matters of opinion, so too is the alleged criminality.

Don’t be too surprised if Mr. Spitzer’s run for governor turns out to be largely bankrolled by trial lawyers. Eliot Spitzer is the best gift to trial lawyers since the invention of asbestos.

There is no way to know beforehand if you have committed fraud under the Martin Act. The only sure way to find out is to read the papers and see if Mr. Spitzer has put out a press release about your company.

TRIAL BY PRESS RELEASE

Trial by press release has certain predictable effects:

1. First, the accused company’s stock will lose half its value in a few days, largely because of the threatened expense of endless litigation.

Daniel Gross, writing in Slate last October, noted that “Spitzer doesn’t like taking cases to trial. Instead, he has developed a more powerful tactic: He exploits the threat of stock declines and business losses to force industries to change… .He didn’t simply indict. He issued press releases.”

In the first Spitzer assault by press release, Merrill Lynch’s stock fell by $10 billion, making it look like a relative bargain to pay $100 million in ransom.

Marsh & McLellan’s stock likewise lost half its value, for a while, and the firm laid off 3000 people.

“A Spitzer blitz,” wrote Henry Manne, “with its inevitable stock price decline, calls for a fast triage response in order to stave off a calamity on the scale of Arthur Anderson or Enron.”

Incidentally, finance and insurance are (or were) important industries in New York City. By some strange coincidence, the unemployment rate in New York City has been remarkably high ever since the Spitzer blitz began – 7.9 percent in 2002, 8.4 percent in 2003, and still 6.1 percent at the end of 2004 (compared with 5.3 percent for the State). This raises another big question: Can New York City afford Eliot Spitzer?

2. Second, unproven accusations about misdeeds by a few individuals are invariably described as proof of and industry-wide “scandal” or “corruption.” Spitzer’s press release about Marsh was titled “Investigation Reveals Widespread Corruption in Insurance Industry.” But smear words such as corruption and scandal have no legal meaning.

In his testimony before a Senate subcommittee, Spitzer complained that “favoritism, secrecy and conflicts” rule the insurance industry. But favoritism, secrecy and conflicts are purely imaginary crimes. Mr. Spitzer might actually hope to criminalize such open-ended sins, along with corruption and greed. But that would replace the rule of law with the rule of lawyers.

3. Third, it’s all about money. Eliot Spitzer has become a tax farmer for Albany, raising close to $4 billion in hush money with only the vaguest hints about disgorging any of it alleged victims. Spitzer deals are always settled in cash without formal charges, due process or even admission of guilt. I hesitate to call this a shakedown or extortion – because neither term seems quite strong enough.

Write a big enough check, or get into bed with Spitzer’s teammates, and the most dramatic threats and accusations will magically disappear.

Marsh & McClellan quickly fired CEO Jeffrey Greenberg because Spitzer asked for his head. And their new CEO, Michael Cherkasky, just happens to be an old friend and former colleague of Spitzer’s. On the same day Mr. Chekasky was hired, Spitzer stopped threatening criminal charges against the company and quietly dropped the complaint’s explicit demand for punitive damages. Did someone speak of corruption?

4. Fourth, Spitzer has apparently appointed himself the nation’s wage and price control czar – three decades after Richard Nixon abandoned that policy. Has involved himself in tinkering with mutual fund fees, Dick Grasso’s employment contract, Marsh & McClellan’s commission structure, and (I’m not making this up) the fact that New York City washroom attendants worked for tips rather than wages.

THE MARSH COMPLAINT

Spitzer’s charges have never been tested in a court of law, for good reason. Trial by press release does not have to let any court making findings of fact, or let the accused face their accusers (usually competitors), or prove anything beyond reasonable doubt. Spitzer’s complaints merely have to dig up a few seemingly juicy e-mail tidbits to be echoed uncritically by the gullible media.

In the Marsh & McLellan and ULR (Universal Life Resources) complaints, Spitzer tries to depict a world in which professional buyers of insurance at the world’s largest corporations are mindless sheep and insurance brokers are their evil shepherds. He told a Senate panel, “the ordinary purchaser of insurance has no idea that the broker he selects is receiving hidden payments from insurance companies, that the advice he receives from the broker may be compromised.” In ULR’s case, these supposedly clueless purchasers include Intel, Colgate-Palmolive, Eastman Kodak, Marriott, United Parcel and Dell. Nearly all of Marsh’s clients are also Fortune 100 firms. These are scarcely innocent babes in the woods. They can and do switch brokers or deal directly with insurance companies.

Mr. Spitzer’s belief that such sophisticated corporate buyers could be routinely overcharged for insurance by one or two insurance brokers without anyone catching on or shopping around is literally unbelievable.

Fortunately, Spitzer’s office eventually put the exhibits online for the Marsh case. That lets us check to see if quotations used in the Complaint against Marsh were ripped out of context. It turns out they often were.

Paragraph 55 of the Complaint claims “Marsh asked ACE to refrain from submitting a competitive bid because Marsh wanted the incumbent, AIG, to keep the business.” This is followed by a quote that seems to suggest that ACE “could get to $850,000 if needed” – the same bid as AIG. But the next sentence of that quote is suspiciously omitted. What is said was, “Apparently both Marsh Atlanta and Client are extremely unhappy with AIG and if we can put offer on table at $800,000 we’ll get it.”

Paragraph 66 lists assorted complaints with the New York office solicited from Marsh regional managers. One is quoted asking, “What are the rules on pricing – are we to quote our numbers or what MGB (Marsh Global Booking) wants us to quote?” The next sentence, however, is curiously omitted. What it said was, “We get more price-driven deals from them [MGB] than anyone. The local offices don’t push us for price the way they do!” This regional manager’s anxiety about pricing was obviously not about being pushed too hard to raise prices (as Spitzer implied) but to lower prices – to make price-driven deals.

Paragraph 63 claims Munich-American Risk Partners disclosed to a client “contingent commissions that were being passed on to the client.” But that is not what the cited letter says. What it actually complains about is that the commissions cannot be passed on, and are therefore burdensome to Munich. The letter said Munich and Marsh should “find a way to share in the financial impact rather than having Risk Partners share the entire burden.”

Paragraphs 64 to 66 echo other self-interested gripes from Munich about not getting much business from Marsh, so why should they even bother to show up at client meetings. Yet the undisclosed part of this same letter admits Marsh wasn’t recommending Munich because Munich’s bids were too high. The business was instead going to Zurich, which did not pay contingent commissions to Marsh. The Munich executive wrote, “Zurich is currently very aggressively pricing umbrella business … We currently stand almost no chance of competing with Zurich … Their pricing approach seems to be just what MGB is looking for… . Pricing still drives that operation [namely, MGB].” The undisclosed complaint from Munich was not that Marsh was charging clients too much, but that Munich’s competitors were charging too little.

Many of the most serious assertions are just unverifiable hearsay, supported by no evidence at all. A key complaint, for example, asserts that, “Typically, Hartford’s underwriters were told to price the quote or indication 25% above a particular number, and that by doing so Hartford need not worry that it would get the business” (59,60). Why would Hartford worry about getting the business? Don’t they want to sell insurance? If Hartford typically quotes too high a price, then Hartford need not ever worry about selling any insurance. Why would they go along with a deal like that?

The complaint says, “A cast of the world’s largest insurance companies … have paid hundreds of millions of dollars for Marsh to steer business their way.” Yet Marsh cannot steer business to one without steering it away from another, so why don’t the others complain?

The only alleged evidence of “steering” is in the final paragraphs 70 through 74, concerning the Greenville South Carolina School District. The choice among four bids came down to ACE and Zurich. ACE paid contingent commissions to Marsh but Zurich did not. Zurich won the bid. If that was steering, Marsh needs driving lessons.

Spitzer does not claim the highest bid won in this case or any other, yet the antitrust portion of the case nonetheless asserts (without a shred of evidence) that “clients purchased insurance at prices higher than they would have paid.” Where’s the proof?

Paragraph 42 asserts that “insurance carriers pass the cost of contingent commissions directly on to the clients in the form of higher premiums” If it that were true then carriers like Zurich who refused to pay such commissions could charge lower premiums and win the bid, as Zurich did against ACE and Munich. No carrier can pass on any cost if another carrier wins the bid.

CONCLUSION

In short, to make his case, Mr. Spitzer had to rely on what the Martin Act refers to as deception, concealment, suppression and false pretense.

The cash pay-off in the Marsh case doesn’t matter much – a capricious Spitzer tax has become price of doing business in New York, at least for finance and related middlemen. But the resulting unlegislated change in the way brokers are compensated, on the other hand, is likely to injure clients and insurers alike – if it spreads and sticks.

Methods of compensating people for their services evolve for good reasons and should not be meddled with lightly.

Contingent fees in the insurance business are often based on the profitability of the business, so that brokers who keep bringing high-risk clients to insurers will not be rewarded for doing so. This solves what economists call an “agency problem” – just as CEOs need incentives to act in the stockholders’ interest rather than their own, independent brokers need some incentive to act in the carrier’s interest rather than their own. Contingent fees for renewing policies likewise provide a clear incentive for brokers to keep clients satisfied, to minimize needless churning, and to communicate special client needs to insurers. It is not at all clear that any alternative incentive system would work as well.

Yet Mr. Spitzer’s myopic vision of “conflict” demands that insurance brokers stop collecting such fees from carriers, so Marsh and some insurers have capitulated. If all brokers and carriers did the same, however, that would leave only two alternatives. One possible alternative would be to virtually eliminate independent brokerage, reverting to captive single-company agents and direct negotiations between insurance companies and clients. Another alternative might be to charge higher brokerage fees to clients, but high client fees would also tend to eliminate a lot of independent brokerage. So would underpaying brokers.

If Spitzer succeeds in regulating and legislating insurance commissions arbitrarily by the threat of bad publicity and endless litigation, Henry Manne predicted in the Wall Street Journal that “we may witness the demise of specialized insurance-brokerage firms … [with] a decrease in market specialization … [and] economic efficiency.”

In a CNN interview, Spitzer once referred to himself as a “prosecutor-slash-regulator.” He’s become a guerilla regulator, operating with no legitimate authority, rewriting laws and regulations through public threats and private deals. He has appointed himself the nation’s regulatory czar, price controller, legislator and judge.

I am told that Eliot Spitzer is running for Governor of New York. He cannot count on my unqualified support.”